Style-based investment strategies for currencies

Abstract:

In this paper a graphical time-series approach was used to analyse style-based investment strategies for currencies. The styles investigated included momentum, volatility and value, and particular focus was given to understanding whether differences exist in the results between the currencies of developed versus emerging countries. The results showed that differences between emerging and developed currencies were statistically significant for each of the styles studied and that the classification of countries' currencies, as either developed or emerging, was therefore necessary in analyses. Momentum was confirmed to exist in currencies, with a reversion to the mean in the long-term; optimal returns were achieved with the least momentum (quintile five) currencies, using a 10-month look-back period (formation period), three-month look-to period and a two-month holding period. Volatility as a style started out as a particularly good trading strategy, but the results show that the style has been traded-out from around the time of the global financial crisis in 2007 to 2008. Returns from the value style have persisted, with the greatest returns achieved with those currencies most under-valued according to the Big Mac index. The relative strength of the base currency used in the analysis, in this case the U.S. dollar, was found to have a significant impact on the success of the various style-based investment strategies.